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Economic Agents as Imperfect Problem Solvers

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  • Cosmin L. Ilut
  • Rosen Valchev

Abstract

We develop a tractable model of limited cognitive perception of the optimal policy function, with agents using costly reasoning effort to update beliefs about this optimal mapping of economic states into actions. A key result is that agents reason less (more) when observing usual (unusual) states, producing state- and history-dependent behavior. Our application is a standard incomplete markets model with ex-ante identical agents that hold no a-priori behavioral biases. The resulting ergodic distribution of actions and beliefs is characterized by “learning traps”, where locally stable dynamics of wealth generate “familiar” regions of the state space within which behavior appears to follow past-experience-based heuristics. We show qualitatively and quantitatively how these traps have empirically desirable properties: the marginal propensity to consume is higher, hand-to-mouth status is more frequent and persistent, and there is more wealth inequality than in the standard model.

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  • Cosmin L. Ilut & Rosen Valchev, 2020. "Economic Agents as Imperfect Problem Solvers," NBER Working Papers 27820, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:27820
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    References listed on IDEAS

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    4. Rosen Valchev & Nicolas Vincent & Cosmin Ilut, 2014. "Paralyzed by Fear: Rigid and Discrete Pricing under Demand Uncertainty," 2014 Meeting Papers 716, Society for Economic Dynamics.
    5. Mariana García-Schmidt & Michael Woodford, 2019. "Are Low Interest Rates Deflationary? A Paradox of Perfect-Foresight Analysis," American Economic Review, American Economic Association, vol. 109(1), pages 86-120, January.
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    10. Luminita Stevens, 2020. "Coarse Pricing Policies," Review of Economic Studies, Oxford University Press, vol. 87(1), pages 420-453.
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    Cited by:

    1. Carstensen, Kai & Bachmann, Rüdiger & Schneider, Martin & Lautenbacher, Stefan, 2018. "Uncertainty is Change," VfS Annual Conference 2018 (Freiburg, Breisgau): Digital Economy 181572, Verein für Socialpolitik / German Economic Association.
    2. Francesco D’Acunto & Daniel Hoang & Michael Weber, 2020. "Managing Households' Expectations with Unconventional Policies," NBER Working Papers 27399, National Bureau of Economic Research, Inc.
    3. D'Acunto, Francesco & Hoang, Daniel & Paloviita, Maritta & Weber, Michael, 2019. "IQ, Expectations, and Choice," Research Discussion Papers 2/2019, Bank of Finland.
    4. Andrade, Philippe & Gautier, Erwan & Mengus, Eric, 2020. "What Matters in Households' Inflation Expectations?," CEPR Discussion Papers 14905, C.E.P.R. Discussion Papers.
    5. Nimark, Kristoffer P. & Sundaresan, Savitar, 2019. "Inattention and belief polarization," Journal of Economic Theory, Elsevier, vol. 180(C), pages 203-228.
    6. Francesco D'Acunto & Daniel Hoang & Maritta Paloviita & Michael Weber, 2019. "Human Frictions to the Transmission of Economic Policy," 2019 Meeting Papers 339, Society for Economic Dynamics.
    7. Hassan Afrouzi, 2020. "Strategic Inattention, Inflation Dynamics, and the Non-Neutrality of Money," CESifo Working Paper Series 8218, CESifo.
    8. George-Marios Angeletos & Karthik Sastry, 2019. "Inattentive Economies," NBER Working Papers 26413, National Bureau of Economic Research, Inc.

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    More about this item

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E71 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on the Macro Economy

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